Barclays reported record profits of £7.1bn yesterday and ran headlong into a row about bank charges and consumer fears that "free banking" is about to end.

The consumer watchdog Which? claimed banks made a total of £4.7bn in profits last year from fees and interest rates on unauthorised overdrafts. Campaigners urge customers who have paid unfair charges to claim a refund.

The Office of Fair Trading, which has already cut banks' income by £300m by capping default fees on credit cards at £12, is deciding whether fees for unauthorised overdrafts should also be regulated.

The regulatory invention has led to speculation that the "free" banking enjoyed by most customers will end as banks will no longer be able to cross-subsidise their charges. John Varley, Barclays' chief executive, who led the campaign to charge for cash machine withdrawals seven years ago, said he was "very determined" to protect free banking for the "overwhelming majority" of the group's customers.

"I'm committed to free banking because I know it's one of the things that our customers value most," he added.

The bank refuses to disclose how much money it makes from overdraft fees but in total its UK retail banking arm makes £1.2bn in fee and commission income. It admitted sales of payment protection insurance - which is also being investigation by the regulators - were falling.

While Barclays reported a 35% rise in profits to £7.1bn, only a small part of that was made in its UK retail banking arm. For the first time, Barclays generated 50% of its profits outside Britain compared with 20% three years ago. It is setting its sights on further international growth.

Mr Varley has reorganised the bank by putting his new recruit Frits Seegers in charge of global retail and commercial banking while Bob Diamond, the £15m-a-year US banker, still oversees investment banking and fund management.

Mr Diamond runs the biggest generator of profit: the investment bank, Barclays Capital, which achieved a 55% rise in profits to £2.2bn. Overall, the businesses he runs contributed 43% of group profits, which analysts said indicated his importance to the bank. Mr Diamond has bold ambitions for Barclays Capital - which now employs 13,000 compared with 6,000 three years ago - and is now trying to break into the top tier of investment banks for US capital market business.

The worst-performing division was Barclaycard, where profits fell 40% to £382m. The credit card arm has been the cause of the bank's hefty charge for bad debts. Barclaycard's charge for customers failing to repay bills rose 36% to almost £1.5bn, accounting for most of the bank's entire £2bn bad debt charges. But the bank indicated the situation was now improving.

Mr Varley defended Barclays' right to make strong profits. "It's good for this country to have a self-confident bank like Barclays. The financial services industry is growing at four times the rate of the economy - what every strong economy needs is strong banks," he said.

He also rejected the suggestion of Peter Hain, Labour's deputy leadership candidate, for City workers to give two-thirds of their bonuses to deprived communities. "We've got to make sure we attract the best people in the world ... Why on earth would we want to drive talent away," he said. Despite the record profits, executives are unlikely to achieve their full bonus potential as they have failed in their three-year goal to put total shareholder return in the top quartile compared with its peers.

In the UK retail business, Mr Varley said there had been a turnaround after years of flat profits growth. He said he wanted to turn it into the "best bank in the UK". Analysts noted that profits were down if one-off income of £253m for a sale and leaseback deal were excluded. The bank's moribund mortgage business improved although analysts at Dresdner Kleinwort noted the 4% share of net mortgage lending in the second half of 2006 was below its historic share of 6% and well below the 10% when it bought Woolwich in 2000.

The retail bank, now run by Mr Seegers, plans to open 350 branches outside Britain this year, mainly in Portugal, Spain, Italy, the United Arab Emirates and Kenya. "Our natural instinct is to grow organically but we don't rule out acquisitions. Why should we?" said Mr Varley.